Microfinance in Sri Lanka: A Household Level Analysis of Outreach and Impact on Poverty. Ganga Tilakaratna Upali Wickramasinghe

Transcription

1 Microfinance in Sri Lanka: A Household Level Analysis of Outreach and Impact on Poverty Ganga Tilakaratna Upali Wickramasinghe

2 **** This paper was presented at the Fourth Annual Conference on Poverty and Economic Policy organized by the International Development Research Center (IDRC), Canada. University of Laval, Quebec and the Institute of Policy Studies of Sri Lanka, held at Galadari Hotel, Colombo, in June This study was carried out as a part of the Micro Impact of Macroeconomic and Adjustment Policies (MIMAP)- Sri Lanka Phase II Project funded by the International Development Research Centre (IDRC), Ottawa, Canada. Authors wish to gratefully acknowledge IDRC for the financial and technical support. Abbreviations ADB CBO CBSL D.S. Division G.N. Division HH MDGs MFI MPCS NDTF NGO RDB ROSCAS SDB SEEDS TCCS VRP Asian Development Bank Community Based Organization Central Bank of Sri Lanka Divisional Secretary Division Grama Niladhari Division Household Millennium Development Goals Microfinance Institution Multi-Purpose Corporative Society National Development Trust Fund Non-governmental Organization Regional Development Bank Rotating Savings and Credit Associations Sanasa Development Bank Sarvodaya Economic Enterprise Development Society Thrift and Credit Cooperative Society Village Resource Profile 2

3 Contents Abbreviations List of Tables List of Figures Abstract i iii iii iv 1. Introduction Survey Design Microfinance Outreach Informal Sources of Finance Linking Microfinance and Poverty Economic Impact of Microfinance Microfinance and Household Vulnerability Microfinance and Empowerment Conclusions and Policy Implications 35 References 40 Annex 1: Selected Locations for the survey 43 Annex 2: Distribution of Households by Credit Amount and Districts 45 Annex 3: Distribution of Households by Savings Amount and Districts 46 Annex 4: Average Households Credit and Savings from MFIs by Districts 47 Annex 5: Impact of Microfinance: Perceptions of Members of MFIs 47 Annex 6: Distribution of Formal Loans by Income Quintiles 48 Annex 7: Pearson s Correlation: Income with other Variables 48 Annex 8: Pearson s Correlation: Expenditure with other Variables 49 Annex 9: Pearson s Correlation: Assets with other Variables 49 Annex 10: Coefficients of the Simultaneous Equations Model 50 Annex 11: Income Fall and Survival Strategies 51 List of Tables 3

4 Table 1: Distribution of G.N. Divisions by Number of MFIs 07 Table 2: Spatial Outreach of Some Key Microfinance Providers 08 Table 3: Distribution of Households in Different Income Groups by Amount of Credit 12 Table 4: Distribution of Households in Different Income Groups by Amount of Savings 13 Table 5: Distribution of Households in Districts by Amount of Informal Credit 15 Table 6: Credit by Purpose of Borrowing 16 Table 7 Impact of Microfinance: Perceptions of Members of MFIs 19 Table 8: Nature of Risks and Vulnerabilities Faced by Households 31 Table 9: Risks Faced by Households and their Responses 31 Table 10: Risks Faced by Households and their Responses by Income Quintiles 32 Table 11: Utilization of Loans by Women 34 List of Figures Figure 1: Nature of the Sample of Households 05 Figure 2: Density of MFIs in Sri Lanka 07 Figure 3a: Micro Credit Distribution by Districts 10 Figure 3b: Savings Distribution by Districts 10 Figure 4: Distribution of Microfinance Clients by Monthly Household Income 11 Figure 5: Distribution of Informal Credit by Source 14 Figure 6a: Mean Credit and Income by Quintiles 21 Figure 6b: Mean Credit as a of Income 21 Figure 7a: Mean Credit and Asset value by Quintiles 23 Figure 7b: Mean Credit as a of Asset 23 Figure 8a: Mean Income and Savings by Quintiles 30 Figure 8b: Mean Savings as a of Income 30 Figure 9: Who Control Loans of Female Members? 34 4

5 Abstract Microfinance, one of the widely accepted instruments for poverty alleviation throughout the world, has been used in Sri Lanka spanning for over several decades. Despite the long history and the large number of institutions providing microfinance services particularly to the poor, there is limited knowledge on the impact of microfinance on poverty alleviation in Sri Lanka. This study fills this gap by studying some important issues related to microfinance sector: outreach of microfinance, role of informal sources of finance and the impact on poverty and welfare of households. Microfinance services in Sri Lanka have a wide geographical outreach but the extent of outreach of private operators including NGOs and commercial banks in rural areas is rather limited. Although the poor and the poorest groups have been reached by Microfinance Institutions (MFIs), a significant proportion of their clientele seems to be from the non-poor groups. Microfinance has helped households in middle quintiles to increase their income and assets; helped the very poor to increase consumption expenditure; has inculcated savings habits among the poor; has worked as an instrument of consumption smoothing among almost all income groups; and has helped women to increase their social status and improve the economic conditions. The study also finds that informal financial market is pervasive across districts and among different income groups. The study recognizes that financial services alone are not sufficient to raise the living conditions of the poor. To create sustainable micro-enterprise and other economic activities, it is important that MFIs facilitate or directly involve in providing credit-plus services to their clients, particularly to those in low income categories. Development of rural infrastructure facilities is of prime importance to improve the outreach of MFIs in remote rural areas and encouraging the private and NGO sectors to involve more effectively in microfinance provision. The study also stresses the need to take in to account the heterogeneity of microfinance clients and their needs in designing more effective microfinance instruments. 5

6 1. Introduction In recent years, microfinance has been looked upon as an effective instrument for poverty alleviation by many governments, international organizations and donors. Today, there is hardly any donor agency - multilateral or bilateral - that is not active in the field of microfinance. The United Nations General Assembly, in recognition of the significance of microfinance in reducing poverty and achieving the Millennium Development Goals (MDGs), has designated the year 2005 as the International Year of Microcredit (resolution 53/197). The Year aims at raising public awareness of the importance of microcredit and microfinance, supporting sustainable access to financial services and promoting innovation and new partnerships to expand the outreach of microfinance. The term Microfinance refers to the provision of a broad range of financial services such as deposits, loans, payment services, money transfers, and insurance to poor and low income households and, their micro enterprises. 1 The idea of providing credit to the poor as a tool for increasing their income and thereby reducing poverty is not new. What is new in microfinance is the innovative methods of providing credit to the poor (e.g. the usage of social collateral such as group guarantee instead of physical collateral, progressive lending approach, peer pressure and peer monitoring), mobilization of savings from the poor and linking credit provision to savings, social mobilization process that involves awareness building and formation of self-help groups and provision of other services such as insurance to cover risks and distresses faced by the poor. In Sri Lanka, provision of financial services to low income households has a long history dating back to the early years of the 20 th century. Thrift and Credit Cooperative Societies (TCCSs), which were first established in 1911, were the pioneers in providing financial facilities to the poor. Nevertheless, it was only in late 1980s, with the enactment of the Government s Janasaviya programme 2 that microfinance, in its strict sense, began to be widely recognized in Sri Lanka as a central tool for alleviating poverty and empowering the poor. In the 1990s, the expansion of microfinance activities embraced all sectors namely 1 ADB definition of microfinance ( 2 Janasaviya was established by the government in 1989, with the dual objective of short-term income-supplementation and long-term employment creation of the low income households. This had several components which include provision of credit facilities to low income households, improve nutrition, and small enterprise development. 6

7 governmental, non-governmental and cooperative sectors. The establishment of the National Development Trust Fund (NDTF) in 1991 as an apex lending institution was also another turning point in the microfinance sector in Sri Lanka. Currently, there is a wide range of institutions that are involved in providing microfinance services to low income groups. These include, Co-operative Societies (e.g. TCCSs), hundreds of local and international Non-governmental Organizations (NGOs), commercial banks (both state-owned and private) and development banks such as the Regional Development Banks (RDBs) and the Sanasa Development Bank (SDB). In addition, the Government s Samurdhi Savings and Credit Scheme established in 1996 is presently one of the largest social mobilization programmes in Sri Lanka, with over 32,000 village level societies and over 1000 bank branches operating island-wide. Moreover, The Central Bank of Sri Lanka (CBSL) is another key player, which functions as the executing agency of a number of rural credit programs funded by various donor agencies and the Government of Sri Lanka. Despite the large number of institutions involved in providing microfinance facilities in Sri Lanka, their impact on reducing poverty or improving household welfare is not very clear. Only few studies have been undertaken to assess how microfinance have impacted poverty and living conditions of the households in Sri Lanka. Even these studies, in general, are confined to one or few microfinance institutions (MFIs) /programs, or to limited geographical locations (Colombage, S.S., 2004; Shaw, J., 2004; Gunatialka R. and R.Salih, 1999; Gunatilaka et al, 1997; Hulme and Mosely 1996). A comprehensive study covering participants from a wide range of MFIs and diverse geographical locations has been an important lacuna in evaluating the effectiveness of microfinance in reducing poverty in Sri Lanka. Hence, this study attempts to fill some of these gaps in literature related to microfinance by analyzing its outreach and impact at household level. The specific objectives of the study are: - To analyse microfinance outreach with regard to the extent, scale, spatial and depth of outreach in Sri Lanka - To examine the extent and the role of informal sources of finance. 7

8 - To analyse how microfinance has impacted on poverty and living conditions of households, particularly the poor households in Sri Lanka In the next section, we will discuss the design of the household survey conducted in 50 G.N. Divisions to see the outreach and impact of microfinance. The section 3 will look at the outreach of microfinance in terms of extent, spatial and depth of outreach while the section 4 will discuss the extent and nature of informal sources of finance. Section 5 provides a conceptual framework on the link between microfinance and poverty. In section 6, we will analyze the impact of microfinance on various economic variables such as household income, expenditure, assets, housing conditions and employment opportunities. Further, the impact of microfinance in reducing household vulnerability is discussed in section 7 while its impact on empowering the poor, particularly the poor women is highlighted in the eighth section. The final chapter provides some concluding remarks and policy implications. 2. Survey Design Coverage of Household Survey The household survey was designed to cover about 1500 households from 50 Grama Niladhari divisions (G.N. divisions) across 17 districts of Sri Lanka. The survey covered all the districts except those in Northern and Eastern parts of the country. 3 As some villages in Sri Lanka were found to be too small in terms of the number of households, the next lowest administrative unit in the country, G.N. division, was used as the sampling unit in this survey 4. From each of the selected 50 G. N. divisions, a sample of 30 households was selected for conducting the survey. Selection of G.N. Divisions The data from The National Microfinance Study of Sri Lanka (2002) 5 on average per capita loan amount from MFIs by district was used as a basis for allocating the 50 G.N. divisions among the 17 districts. In other words, the number of G.N. divisions from each district was 3 Northern and Eastern parts of Sri Lanka were excluded due to security reasons. 4 Sri Lanka s administrative system from bottom: Village, Grama Niladari division (G.N. division), district secretary division (D.S. division), district and province. 5 Richard Gant et al (2002) National Microfinance Study of Sri Lanka: Survey of Practices and Policies, Co-Sponsored by Aus AID and GTZ. 8

9 selected in proportion to the average per capita loan amount of the given district. According to this method, the number of G.N. divisions allocated for a district varied between two and five. 6 Once the number of G.N. divisions from each district was decided, the random sampling method was used to first select the (decided number of) District Secretary divisions (D.S. divisions) within each district totalling up to 50 D.S. divisions. Then, within each of the selected 50 D.S. divisions, one G.N division was selected using the random sampling method. 7 Selection of Households A semi-controlled method was used to select a sample of 30 households within each of the selected G.N. divisions. Initially, it was expected to select 80 percent of the sample (24 out of 30 households from each G.N. division) from the participants of MFIs, while the rest from the non-participants. In each G.N. division, participants were selected randomly using the member lists of all the MFIs in the area. The non-members were selected randomly using a list of names (e.g. election name list) obtained from the Grama Niladari/Village Headman (excluding the names of the MFI members). The latter group was used as the control group in this study. Nevertheless, in some G.N. divisions, a slight deviation from the expected ratio of participants and non-participants of MFIs had to be experienced due to several reasons. For example, there were some households who claimed to be non-participants of MFIs at present, but who were found to have obtained financial services from MFIs during the last two years. Similarly, some other households who claimed to be non-participants as they had taken no loans from MFIs were found to have saved with MFIs. Reclassification of both these categories as microfinance participants led to some changes in the size of the participant and non-participant groups. In the data cleaning process some household questionnaires had to be taken out from the sample due to inconsistencies. 6 The justification for using this method as a basis for allocating the number of G.N divisions from a district, is that it was expected that selecting more areas/locations from districts with higher involvement of microfinance (as against more areas from districts with relatively higher level of population- the method most frequently used), would be more appropriate to analyze the impact of microfinance on household welfare in the country. 7 See Annex 1 for the Map and the name list of the 50 G.N. divisions selected for the survey 9

10 The final sample taken for the analysis consisted of 1,480 households of whom 1,286 were participants of MFIs while the remaining 194 were non-participants of MFIs. The participants of MFIs were found to be a heterogeneous group in terms of the type of financial services obtained by them from MFIs. For example, out of the 1,286 participants of MFIs, only 1,153 households had borrowing, while the rest had only savings with MFIs. There were 1,108 households in total who had saved with a MFI. Overall, only 975 households of the total participants had both credit and savings from a MFI. The distribution of households according to type of financial services received from MFIs is depicted in the Figure 1. Figure 1: Nature of the Sample of Households E = {total sample} C = {participants with credit} S = {participants with savings} E Participants n ( C S )= 1,286 C S Total sample n ( E )= 1,480 Participants with Credit n ( C ) = 1, Participants with Savings n ( S ) = 1,108 Credit and Savings n ( C S ) = 975 Non participants n (C S ) = 194 Design of Questionnaires The survey was conducted in two phases using two types of questionnaires: First, a Village Resource Profile (VRP) was prepared for each of the 50 selected G.N. Divisions by collecting village level (G.N. division level) information including infrastructure facilities (e.g. transport, electricity, communication) and various MFIs in the area, etc. Second, a household level survey was conducted to obtain various data from the selected households such as households income, expenditure, assets, economic activities, risks and vulnerabilities and details of credit and savings. The data obtained using both the VRP and the Household questionnaire was used to analyze the impact of microfinance on poverty and welfare of the households in Sri Lanka. 10

11 Furthermore, the outreach of microfinance sector in Sri Lanka and the extent and role of informal sources of finance in the country were also looked at in this study. 3. Microfinance Outreach In analyzing the effectiveness of microfinance in alleviating poverty, it is crucial to look at the outreach of MFIs. It is argued that microfinance can play an important role in poverty alleviation only if the extent of outreach is reasonably large. On the contrary, if MFIs are restricted to only few geographical locations or serve only a small fraction of the population or the poor, their importance in poverty alleviation efforts would be limited. Outreach of microfinance sector can be looked at in numerous aspects: extent and scale of outreach, spatial outreach, depth of outreach, etc. 8 The findings of the survey, conducted in 50 G.N. divisions across 17 districts in Sri Lanka, show that there is a wide range of microfinance service providers in the country. Broadly, they can be classified into: (i) formal institutions, (ii) semi-formal institutions and (iii) informal sources. Formal institutions include commercial banks - both state owned and private banks and development Banks. Semi-formal institutions include various NGOs and cooperative societies. A considerable number of small NGOs and community based organizations (CBOs) operate only in one or few locations. Moreover, a wide range of informal sources exists that provide small scale financial services to individuals and households. Such sources include professional money lenders, shop keepers and Rotating Savings and Credit Associations (ROSCAS). Nevertheless we have defined Microfinance Institutions (MFIs) to include only the institutional sources, that include formal and semiformal sources providing microfinance services as their major or the important part of their business. 9 The results of the survey show a reasonably wide geographical outreach of microfinance services in Sri Lanka. As shown in figure 2, all the selected G.N. divisions have at least one 8 For details on various dimensions of outreach of MFIs, see Chapter 13 of Sanderatne (2004), Leading Issues in Rural Finance, PGIA, University of Peradeniya, Sri Lanka 9 Note that this is somewhat different to the ADB definition that defines MFIs as institutions whose major business is the provision of microfinance services (ADB, 2000). The reason for this deviation is that, in Sri Lanka, there are a large number of NGOs, commercial banks, etc, that are involved in microfinance as an important part of their activities, but not necessarily as their major business. 11

12 MFI. The number of MFIs in a G.N. division varies between one and eight with an average of four percent of the G.N. divisions have access to at least three MFIs. On the contrary, 6 percent of the selected locations (3 G.N. Divisions) were found to have access to only a single MFI, i.e. the Government s Samurdhi Credit and Savings Societies (Table: 1) Figure 2: Density of MFIs in Sri Lanka Table 1: Distribution of G.N. divisions by Number of MFIs No of MFIs in a G.N. Division No of G.N. Divisions Source: Microfinance Survey 2004, IPS of G.N. Divisions Total Table 2 shows the spatial outreach of some key microfinance providers in the country. As it shows, the spatial outreach of MFIs varies largely from one institution to another. It is interesting to find that the government s Samurdhi Credit and Savings programme operates in all the G.N. divisions covered in the survey. The TCCSs, one of the oldest credit organizations in the country, have shown a spatial outreach of approximately 56 percent, 10 Note that in some cases even if the MFI is not located within the selected G.N. Division, if it is located close by but within the same D.S Division and more than 10 of the selected household sample from the G.N. Division has access to it, we consider it as that MFI having outreach in the G.N. Division concerned. The reason to do this is that there are many households who make use of nearby financial institutions located within the same DS division, when there is no financial institutions in the GN division they live in. 12

13 followed by the Multi-Purpose Corporative Societies (MPCSs) with 40 percent outreach. Moreover, the RDBs have 30 percent coverage of G.N. divisions in Sri Lanka. Nevertheless, the majority of NGOs (with very few exceptions like SEEDS) has relatively lower spatial outreach, where many of them are represented in less than 10 percent of the G.N. divisions in the country. Furthermore, the private commercial banks were not found to operate in any of the randomly selected 50 G.N. divisions, although few households (less than 10 percent of the sample from a G.N. division) transacts with private commercial banks, located further away from their area of residence. Table 2: Spatial Outreach of Some Key Microfinance Providers Coverage of G.N. Divisions (No) Spatial Outreach- (Coverage of Divisions -) MFIs Samurdhi Savings and Credit Program TCCSs MPCSs Regional Development Banks (RDBs) SEEDS People's Bank Farmers' Organizations 5 10 Bank of Ceylon 4 8 Fishermen's Organizations 4 8 Arthacharya Foundation 3 6 Ceylinco Grameen bank 2 4 Note: In addition to the above Institutions, the survey found a number of other MFIs, with a spatial outreach of less than 5 per cent Source: Microfinance Survey 2004, IPS A number of factors limit the spatial expansion of MFIs, particularly to remote rural areas. First, remote areas are often associated with poor or inadequate infrastructure facilities such as roads, transportation, electricity and communication networks. Second, many remote areas, offer only limited opportunities for non-agricultural activities, thereby limiting the number of clients a MFI can serve. Poor infrastructure often raises unit cost of operating businesses including microfinance services. As a result, extending outreach (spatially) to remote areas could often lead to higher unit cost of lending and hence, can have adverse impacts on institutions. Moreover, excessive expansion of MFIs is also associated with difficulties in monitoring their clients. 13

14 We also looked at the distribution of households (who are participants of MFIs) by the total amount of credit obtained. It was found that the total amount of credit obtained by the participant households during the last two years range from less than Rs. 3,000 to over 100,000 with an average of about Rs. 27, More than 50 percent of the participants had borrowed over Rs. 10,000, while about 20 percent had borrowed over Rs. 30,000. However, about 10 percent of the participants of MFIs were found to have taken no loans (while they have only saved with MFIs). Nevertheless, there is a significant variation in credit amounts obtained by households across districts. For example, in the districts of Badulla and Gampaha, only less than 10 percent of the participants had their total borrowings over Rs. 30,000, while it was nearly 45 percent in Kalutara district. Moreover, nearly 23 percent of the borrowers in Kalutara district had obtained credit over Rs. 100,000. On the contrary, no total borrowings over Rs. 100,000 were found in the districts of Badulla and Galle, while in majority of other districts the figure was less than five percent. 12 It is also important to look into the household savings, the other significant dimension of microfinance. Household savings with MFIs are observed to vary between less than Rs. 1,000 to over 100, The average savings of the participants of MFIs is Rs. 7,526. However, 15.4 percent of the households had savings less than Rs. 1,000 while another 13.8 percent of participants had no savings. Savings of over 80 percent of the households were found to be less than Rs. 10, On the distribution of savings across districts, we observed considerable variations. For example, in Badulla district, about 60 percent of the households have savings less than Rs. 1,000 or have no savings. Moreover, in many districts, including Anuradhapura, Badulla and Ratnapura, household savings in MFIs are less than Rs. 25,000. On the contrary, in districts like Kalutara, nearly 25 percent of the households have savings above Rs. 25, Further, we ranked districts according to the average household credit and savings with MFIs. 16 The Figures 3a and 3b clearly depicts the district-wise variation in average 11 Note that in this paper, credit amount refers to the total credit obtained from MFIs by households during the last two years. 12 See Annex 2 for the distribution of households by credit amount and district 13 Note here household savings refer to total household savings in MFIs during the last two years. 14 Data on the amount of savings were not available for about 77 households (6 percent) in the sample. This is due to unawareness of the households about the exact level of savings they have in the bank or in some cases, unwillingness to reveal the information about the savings. 15 See Annex 3 for the distribution of households by savings amount and district 16 See Annex 4 for the Average Credit and Savings from MFIs by District 14

15 household credit and savings. As shown in Figure 3a, Kalutara district recorded the highest average credit amount, followed by Monaragala district. The districts of Badulla, Galle and Gampaha had the lowest amount of credit from MFIs. Similarly, figure 3b, shows that Kegalle and Kalutara with highest amount of savings with MFIs. On the contrary, Badulla had the lowest average savings indicating relatively poor microfinance operations in this district. Figure 3a: Microcredit Distribution by District Figure 3b: Savings Distribution by District Source: Microfinance Survey 2004, IPS When assessing the outreach of microfinance sector, it is also important to look at the depth of outreach -that is whether the MFIs have reached the poor groups- particularly the poorest of the poor. Several studies on microfinance have shown that many MFIs tend to serve better-off poor (moderate poor) and the vulnerable non-poor categories, rather than the poorest groups (Hulme and Mosely 1996, Sebstad and Cohen, 2000). There are number 15

16 of reasons for why the MFIs may not reach the poorest groups. On one hand, the demand for credit from the extreme poor may be limited as they often lack capacity for undertaking micro-enterprises owing to lack of skills, technical know-how and marketability of products. The existing demand for credit by the poorest groups is often for consumption needs. On the other hand, many MFIs may not be willing to serve the poorest groups as they are considered to be risky and have less capacity to pay back loans and hence may adversely affect on the viability of the MFIs. In order to see whether MFIs have reached the poor and the poorest groups, households were categorised according to their average monthly income. As portrayed in Figure 4, monthly income of about 36 percent of the participants of MFIs is less than Rs. 5,000, including 6 per cent with income of Rs. 1,001-2,500 and 3 per cent with income below Rs. 1,000 a month. These categories can be considered as the poor households. However, as shown by the figure 4, nearly 40 percent of the participants of MFIs have a monthly income of over Rs. 7,500 while about 21 percent have more than Rs. 10,000 a month. Further, there area about 5 per cent of microfinance clients with an average income of even higher than Rs 20,000 a month. These findings imply that that MFIs have reached the poor well as the poorest groups, however, a significant proportion of microfinance clients are from the notso-poor or the vulnerable non-poor categories. Figure 4: Distribution of Microfinance Clients by Monthly Household Income 30 of Total HHs Income Levels Source: Microfinance Survey 2004, IPS 16

17 Moreover, the survey data confirm that the total borrowings of the participants falling into low income groups are relatively small compared to the richer income groups. For instance, as shown in Table 3, more than 50 percent of households in the lowest income group (i.e. less than Rs. 1,000 a month) have borrowed less than Rs. 5,000, including nearly 29 percent with no borrowings during the last two years. On the contrary, in the richer income groups, less than 25 percent of the households have borrowed less than Rs. 5,000 while the majority have borrowed relatively larger amounts. Table 3: Distribution of Households in Different Income Groups by Amount of Credit Income Level No Loans <3,000 3,001-5,000 Loan Amount 5,001-10,000 10,001-30,000 30,001-50,000 50, , ,000 < < < Total Source: Microfinance Survey 2004, IPS Table 4 provides the distribution of households by total savings in MFIs and income level. Similar to the case of credit, there is considerable variation in regard to savings across different income groups. It is interesting to note that over 75 percent of the poorest category (with monthly income less than Rs. 1,000) had savings less than Rs. 5,000 in MFIs. However, in higher income groups, a considerably higher proportion of households have relatively higher amounts of savings. 17

18 Table 4: Distribution of Households in Different Income Groups by Amount of Savings Income level No Data No Savings < Savings Amount < < < Total Source: Microfinance Survey 2004, IPS 4. Informal Sources of Finance Despite the availability and widespread use of MFIs, the informal financial market seems to have continued to play an important role, particularly in the rural areas of Sri Lanka. In this section, we look at the extent and nature of informal financial market and the reasons for the pervasiveness of informal lending in Sri Lanka. The survey results show that nearly 32 percent of the households in the total sample have borrowed from various informal financial sources. It is interesting to find that about 34 percent of the participants of MFIs also use informal financial markets. (The figure is only 20 percent for the non-participants). The informal financial sources include friends and relatives, shopkeepers or traders, professional money lenders, ROSCAS, landlords and employers. It was found that friends and relatives account for over 53 percent of the total amount of credit obtained from the informal sources. This is followed by money lenders (about 20 percent) and traders/shopkeepers (about 14 percent). The importance of employers was found to be marginal. In terms of the number of loans, traders/shopkeepers were found to be the second largest source of informal finance (friends and relatives being the first), indicating its importance particularly as a source of small-sized loans. As shown in Figure 5, traders and shopkeepers account for approximately 38 percent of the total number of informal loans, followed by money lenders who account for 10.7 percent. 18

19 Figure 5: Distribution of Informal Credit by Source F & R M oney Lenders Traders ROSCAS Employer Other Source Amount of Loans () Number of Loans () Source: Microfinance Survey 2004, IPS The results show that on average, total informal credit (as a percentage of credit obtained from MFIs) is about 15 percent. However, considerable variations were observed across the districts. For instance, in districts of Hambantota, Puttalam, Colombo and Nuwaraeliya, informal credit accounts for about percent of the credit from MFIs. On the contrary, in the districts of Gampaha and Ratnapura, the informal credit (as a percentage of credit from MFIs) was less than five percent. Further analysis may be needed to ascertain why this may have happened. As shown in Table 5 the amount of informal credit obtained by households varies from less than Rs. 1,000 to over Rs. 100, However, the average credit amount from informal sources is relatively small (Rs.10, 862) compared to borrowings from MFIs. The data show that over 60 percent of the households have borrowed less than Rs. 5,000, while about 20 percent have borrowed less than Rs. 1,000 from informal sources. In some districts like Matale, over 90 percent of the households have borrowed below Rs. 5,000. Overall, only less than 10 percent of the households have borrowed more than Rs. 25,000 from informal sources. Moreover, in some districts like Anuaradhapura, Badulla, Gampaha and Kandy, no household have borrowed more than Rs. 25,000 from informal sources. In addition, informal credit distribution by household income level shows that households of various income categories tend to use informal sources fairly equally to fulfil their credit needs. 17 Note here informal credit refers to total credit borrowed from informal sources of finance during the last two years. 19

20 Table 5: Distribution of Households in Districts by Amount of Informal Credit Loan Amount District < < Anuradapura Badulla Colombo Galle Gampaha Hambantota Kalutara Kandy Kegalle Kurunegala Matale Matara Monaragala Nuwaraeliya Polonnaruwa Puttalam Ratnapura Total Source: Microfinance Survey 2004, IPS Table 6 shows the distribution of credit according to the purpose of borrowing. It is interesting to find that over 40 percent of the total amount of credit from informal sources has been obtained for consumption purposes 18. In terms of the number of loans from the informal sources, consumption loans account for over 58 percent. This is significantly higher compared to the credit borrowed from MFIs for consumption purposes. For example, only about seven percent of the total loan amount from MFIs has been used for consumption purposes. Moreover, more than 25 percent of the informal loans have been obtained for income generating activities. However, the amount of loans obtained from MFIs for such activities is much higher (about 58 percent) compared to informal sources. 18 Consumption purposes here include buying food and other goods, medical expenses, family events such as weddings, funerals and childbirth, etc. 20

21 Table 6: Credit by Purpose of Borrowing Amount of Loan Number of Loans Item MF Informal MF Informal Income generation activities Purchasing or improving assets Consumption Repaying debt Other Total Source: Microfinance survey 2004, IPS A number of reasons can be identified for the pervasiveness of the informal financial sources. First, the flexibility for borrowing without restrictions in terms of the purpose is a key factor contributing to importance of informal finance. As shown earlier, many people tend to borrow from informal sources to meet their consumption needs. Many MFIs, on the other hand restrict credit facilities largely for productive activities or income generating activities. Second, many formal financial institutions like banks tend to operate only in limited areas, hence many people, particularly those living in remote rural areas, have little access to them. Third, despite the relatively good depth of outreach by some MFIs, it was found that a significant proportion of the clients of many MFIs tend to be the better-off poor or the vulnerable non-poor categories. The poorest of the poor, who are often being excluded from many formal and semi-formal financial institutions, find it necessary to rely on the informal sector for credit. Fourth, the results revealed a number of other factors for the persistence of informal finance in the country, which include better accessibility, flexibility in repayments and simplicity in obtaining loans. Fifth, there is no collateral requirement when borrowing from informal sources such as friends, relatives and traders/shopkeepers which is another contributory factor for the continuing importance of informal finance. 5. Linking Microfinance and Poverty In analysing the impact of microfinance on poverty, first it is important to understand the concept of poverty and how microfinance can impact on its various dimensions. 21

22 Poverty is a multi-dimensional phenomenon, which needs to be addressed in all its many dimensions. As described in the World Development Report 2000/2001, the poor often lack adequate food and shelter, education and health, deprivations that keep them from leading the kind of life that everyone values. They also face extreme vulnerability to ill health, economic dislocation, and natural disasters. They are often exposed to ill treatment by institutions of the state and society and are powerless to influence key decisions affecting their lives. These are all dimensions of poverty. 19 Based on this description, the key dimensions of poverty can be broadly classified into three: (i) economic dimension, often measured by the level of income and expenditure, ownership of assets, and employment; (ii) vulnerability to risks and income failures; and (iii) powerlessness and low social status. It is argued that microfinance has the potential to impact directly or indirectly on each of the dimensions of poverty. (i) Tackling economic dimension of poverty: It is claimed that microfinance can be an effective instrument to raise income, production and employment of the poor households. Lack of access to credit has, therefore, been considered as a major obstacle for them to raise their income and production levels. The formal institutions such as banks have bypassed the credit needs of the poor due to lack of credit worthiness, higher transaction costs or perceived higher default rates. The lenders in the informal sector are often considered to charge exorbitant rates of interest. Thus, it is argued that microfinance, by providing financial services to individuals, households and micro-entrepreneurs, promotes income and employment generation opportunities for the poor. (ii) Reduction of Vulnerability: The poor suffer not only from low incomes but also from various vulnerability and risks. They often lack reserves to fall back upon in times of need or buffers to absorb the shocks of income losses. It is claimed that microfinance programs that facilitate savings among the poorer segments and provide access to credit facilities and insurance services help the poor to accumulate assets (expand the asset base) and strengthen their capacity to deal with risks. 19 World Bank, 2000, World Development Report 2000/2001: Attacking Poverty 22

23 (iii) Empowerment of the poor, particularly women: Microfinance programs are said to help the poor, particularly the poor women to gain economic and social empowerment. Through the provision of financial services to improve income, assets and employment opportunities, microfinance programs help the poor to gain economic empowerment. In addition, the social mobilization process, which often accompanies financial services in many microfinance programs, contributes to build social assets such as social networks, group/society membership, mutual trust and help. Participation in microfinance programs can also help improving self-reliance, social recognition and social status of the poor. These are some elements of empowerment which can be gained through microfinance programs. 5. Economic Impact of Microfinance In this section, we will look at the impact of microfinance on various economic dimensions of poverty, i.e. household income, expenditure, assets, housing conditions and employment, using both qualitative and quantitative approaches. Household Income An expanded income gives the households many options: they can increase consumption possibilities, allow the household the possibility of saving for the future, reduce the vulnerabilities arising from future income failures, gives the children better educational opportunities, and so on. Therefore, an expansion of household income is one of the most desirable household outcomes regardless of the current level of income. A slight improvement of income of the poor may not be much in absolute terms, but the marginal benefits may be much higher in comparison to their rich counterparts. As a result, household income has a particular place in all the poverty alleviation programs. The microfinance programs all over the world make attempts to raise the level of incomes of their participants. Sri Lanka s microfinance programs are no exception in that a significant part of the effort is geared towards achieving the objective of raising household incomes. Therefore, the impact of microcredit and other financial services on income needs to be evaluated to see the extent to which microfinance programs have been successful in alleviating poverty. 23

24 We asked the households a relatively straightforward question: has income changed as a result of their participation in microfinance programs? A relatively large percentage of households (i.e., 44.2 percent) indicated that it was indeed the case. A larger percentage of households (i.e., 53.6 percent) seem to think that there was no change of income as a result of their participation in microfinance institutions. (See Table 7). Nevertheless, the fact that microfinance programs have enabled 44 percent of households to increase their income is a welcome relief given the difficulties that development planners experience in raising incomes of households in developing countries owing to a well-known set of constraints. We were interested to find out the distribution of the households who experienced a positive change according to income quintiles 20. We find that the households in different income quintiles have only slight variations with respect to positive benefits. For example, 38.8 per cent of households in quintile 1 had indicated that their income rose, while the percentage for all the remaining quintiles were 38.7, 46.5, 40.8 and 57.9, respectively. It is interesting to note that relatively higher proportion of households in higher quintiles (compared to lower quintiles) has experienced improvement in household income, owing to their participation in MFIs. Table 7: Impact of Microfinance: Perceptions of Members of MFIs Impact on Extent Total Sample First quintile Second quintile Third quintile Fourth quintile Fifth quintile Increased Income No impact Decreased Increased Asset No impact Decreased Increased Housing No impact Decreased Increased Employment No impact Decreased Increased Savings No impact Decreased Source: Microfinance survey 2004, IPS 20 Households were allocated to quintiles (five equal groups) based on per capita household monthly income. 24

25 In the above case we simply allocated households based on their responses to the question if the participation in microfinance has improved their income. This does not say anything about the possibility of having some impact of credit or other variables on income here. The impact of credit on income is of particular interest to us. Therefore, we allocated households not only according to the income quintiles but also according to the extent of loan obtained. 21The new distribution offers some interesting insights. First, we find that the highest number of households (i.e., 27 percent) have obtained loans within the range of Rs. 10,000 to Rs. 30,000. Within that category of households who obtained loans (i.e., Rs. 10,000 to Rs. 30,000), income quintile four has the highest number of households. Second, the Pearson Chi Square test confirmed that there is a significant difference among the income groups with respect to loan amounts 22. Since there seems to be some association between the loan amounts and income levels of households, it is of interest to calculate the magnitude of this association. The simple correlation coefficients were calculated between the total income and a number of other variables viz. the total loan amount, total asset value, the number of income earners in the household, occupation and education level of the household. 23 As for the correlation between income and loan amount, we find that there is a significant, positive correlation for the whole sample having a correlation coefficient of The correlation coefficients were also calculated for different quintiles, and we observe a significantly positive correlation between credit and income among the middle income quintiles (2 nd, 3 rd and 4 th quintiles), while it is not significant for the poorest and the richest groups. It is of particular interest to see the extent of credit obtained by households in relation to their income. Figure 6a shows the actual values for household mean income against the average monthly loan amount obtained by households 24. This suggests that the higher income groups have obtained more loans from microfinance institutions. One may erroneously conclude that even the microfinance schemes favour the relatively rich households. However, once the percentage share of loans in relation to their monthly 21 See Annex 6 for distribution of loans by income quintiles 22 This is significant at α = 0.01 level. 23 See Annex 7 24 Average monthly loan amount was calculated by dividing the total loan amount obtained during last two years by 24 month. 25

26 income takes into consideration, a totally different picture emerges, which shows clearly that in relation to the mean income levels of the poor, they have obtained much higher amount of loan than the rich. (Figure 6b) The loan amount as a percentage of mean monthly income is 20.5 percent for the poorest quintile, while it is 12.5 percent for the richest quintile. This ratio declines for each quintile except for the fourth where there is a slight upward trend compared to the third quintile. This pattern indicates that for the poorer groups, the amount of credit obtained from MFIs, though small in absolute terms, is much larger in relation to their income levels. Figure 6a: Mean Credit and Income by Quintiles Figure 6b: Mean Credit as a of Income Rs Income quintiles Mean monthly income Mean monthly credit Income quintiles Source: Microfinance survey 2004, IPS Household Expenditure Expenditure is another critical variable in analyzing the effect of microfinance on household welfare. A higher level of household expenditure is generally associated with higher consumption and better standard of living. A microfinance scheme may exert a positive impact on household welfare through their effects on expenditure at all levels, but the marginal effect would be the highest among the lowest income groups. In order to see if such a relationship exists between microcredit and household expenditure 25, the Pearson correlation coefficients were calculated for the whole sample as well as for quintiles. The Pearson s correlation coefficients between loan amount and expenditure are significant for the whole sample as well as for all the quintiles Household expenditure used for analysis throughout the study mainly consists of consumption expenditure. 26 See Annex 8 26